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A study by OFS Capital questions whether Brazil’s local content law is a development policy or additional burden.
The inability for some exploration and production companies to hit local content targets in Brazil is resulting in hefty fines and could be creating a burden on not only companies but also the country’s competitiveness.
Brazil’s requirement, which mandates companies contract with Brazilian suppliers when offerings present conditions of price, term, and quality equal to that of international vendors and competitors, could partly explain why Brazil has failed to become one of the top five oil-producing countries in the world, according to investment banking firm OFS Capital.
The issue was examined by OFS in a study that noted concession holders in previous rounds of bids for exploration blocks have been fined for not meeting local content (LC) mandates established by the National Agency of Petroleum (ANP).
“Reasons for not meeting the proposed LC targets are a combination of several factors: among them lack of availability of suitable equipment in the domestic market; and even decisions by companies to import equipment that could be purchased in Brazil,” the study explained. “The difficulties in meeting LC targets and the lack of appetite by some suppliers to invest in R&D for locally manufactured equipment are likely to continue to play an important role in determining the higher final cost of projects in the coming years.”
Fueling criticism of LC are high costs needed to achieve the requirement. Operators could get better deals for equipment and service, in some instances, by opting not to contract with Brazilian companies. To make its point, the report used the cost difference for a seawater lift pump comparing the US price and the Brazilian price. In just about every instance – including raw material, inputs and components, labor, capital costs, and margin – the price was higher in Brazil. With the exception of labor, the other components’ margins of difference were in the double digits.
“Clearly, there is long way for the Brazilian government and Petrobras to go to close the gap between the international cost and the local cost, regardless of standards, guidelines, and/or contractual clauses for ‘local content’ in future bidding round and contracts,” the study stated.
The law aims to preserve Brazilian interests by expanding the local labor market, promoting free competition, and improving the country’s competitiveness, the study pointed out. The minimum local content requirement for exploration projects is 55%. However, the percentage was between 25% and 30% for participants in the 7th and 8th bidding rounds between 2005 and 2008. That is resulting in fines this year based on the head of local content coordination at ANP, according to the study.
Despite the goals of the law, surveys mentioned in the study pointed to the concerns of the offshore industry. A survey conducted by ABESPetro – the Brazilian Association of Petroleum Services Companies – revealed that 32% of its members rated labor as a bottleneck of the industry, while 12% said it was local content. Another survey, conducted by the International Quality and Productivity Centre, showed 34% of respondents said the main barrier to meeting LC requirements was the price of domestic products, and 25% cited a lack of clarity about the rules and requirements.
The study also noted a July 2012 interview with Brazil Energy magazine in which Paulo Rodrigues Alonso, coordinator of Petrobras’ LC program, said LC requirements are in line with the maximum capacity delivered today by the Brazilian industry. However, he added that the company will not allow LC to impact cost and time delivery of its projects.
Petrobras’ business and management plan for 2012-16 includes E&P investments of US $141.8 billion, of which $131.6 billion is set aside for operations in Brazil, according to the company’s website. Projects and needs include rigs, platforms, and vessels along with new refineries, LNG regasification units, and biofuels, electric power, and fertilizer plants.
With Brazil predicted to become one of world’s five largest oil producers by 2020 and more bidding rounds set for 2013, the study gives advice to future newcomers doing business in Brazil: pay close attention to local content requirements and fines.
“Finding the right Brazilian partner is a critical issue in order to short-circuit some of the bureaucracy and save time in the process of becoming a qualified supplier with CadFor – the ONIP and Petrobras supplier register,” the study said. “This must be considered even before the challenges of finding funding for projects, and in assessing whether there is an adequate return on the investments to be made.”
The firm predicts LC requirements will likely increase in the future, considering Petrobras’ increasing investments.
“We might expect major operators and some big suppliers to take a proactive approach and make a decision to invest more in local content, which will be reflected in their bidding proposals,” the study stated. “Increased competition will provide powerful motivation combined with the carrot-and-stick approach of fines, which ANP is expected to focus on in the coming months. Consequently, we believe that the pressure for local content will only increase over the next few years.”
Contact the author, Velda Addison, at firstname.lastname@example.org.